Monday, April 11, 2011

A commodity price blowoff?

As we stand on the cusp of Earnings Season, the market saw a number of important reversals last week. First of all, I have been watching the Dow Jones Transportation Average to see at what point Mr. Market gets spooked by rising oil prices. To my surprise, the Transports broke out to new recovery highs despite $110 and later a $120 Brent price. When WTI broke above $110 last week, the Transports broke down below their upside breakout level, which became a level of support.

The CRB Index also broke out to new highs last week indicating commodity strength and rising inflationary expectations.

Even Dr. Copper, which I had voiced concerns in the past because it was in a minor downtrend, has rallied through the downtrend line and appears to be in a sideways consolidation pattern.

What to make of these reversals?
What to make of these reversals? Is it a sign of rising inflationary expectations, which will certainly mean the end of QE2 and no QE3, as well as foreshadowing the end of ZIRP and rising rates?

The blogger ChessNwine (via Abnormal Returns) had a terrific insight about the current conditions:
Going back to 2008, we can pretty clearly see that equities, particularly energy stocks. stalled out and rolled over weeks (in some cases months) before crude topped out at $147 a barrel. I can vividly recall traders aggressively buying energy stocks to no avail, as crude mached higher on a daily basis amid CNBC’s “Black Gold” banner on the top of the screen, following crude’s tick-by-tick fluctuations. Indeed, those traders who bought energy stocks simply because crude was going higher were in for a rude awakening over the next few months, especially if they did not have the discipline to cut losses.
In other words, if energy stocks weren't rising with oil prices, then it may mean trouble for the markets. The chart below of the ratio of XLE to oil prices show precisely that condition.

This looks like a commodity price blowoff to me and blowoffs don't end well. My inner investor believes that the thought of getting ready to sell in May (or earlier) continues to sound good. My inner trader is staying long but keeping very tight stops as a way of defining acceptable risk levels.

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